There has been a sudden surpising worry by some that the VAT rise in the UK in January will reduce growth next year. The official confirmation of this from the OBR should not be a great or new revelation.The point is the growth rate is unsustainable given the very high level of borrowing, so if you do not bring the deficit down you could end up with a far worse outcome. Of course a material tax rise cuts what people can spend on other things. It is part of the price of trying to reduce the inherited unacceptably high deficit. Whether you cut the deficit by tax rises or by spending cuts, forecasters will say it will reduce the growth rate of activity.Forecasters rarely offer you the alternative forecast, to show you what would happen if you do not tackle the deficit and you enter a Greek style crisis.
The case for doing it has always been that if you do not cut the deficit, the deficit may damage the economy more and overwhelm us all. If the UK lost the confidence of world markets as overborrowed Greece and Ireland have done, much bigger cuts and tax rises would be forced on us. Cutting the deficit is a necessary policy to prevent a worse economic outturn.If you keep a deficit which is too high interest rates are forced up, making many worse off. If your deficit loses you the confidence of the world’s money lenders the government could be forced to cut much more from public spending, as Greece and Ireland have discovered.
Some tax rises can be self defeating. VAT is probably the least bad tax option. Hiking the rates of CGT, Income Tax and profits tax might result in less revenue being collected. It is all too easy to put people off enterprise. You can drive them or their profits and earnings abroad very quickly. Higher rates of Income Tax and CGT are more damaging to tax revenues and the rate of business investment and growth than higher VAT.
Ireland is being lectured by her Euroland partners that she should increase her Corporation Tax rate to cut her deficit more. It is now popular to claim that all of Ireland’s real economic achievement prior to 2007 was false, and that all the policies which brought that about were wrong. It is true that in the later stages of Ireland’s great period of growth poor banking regulation led to too much credit, driving asset prices too high. It is also true that belonging to the Euro kept interest rates and the exchange rate at too easy a level for too long, making a credit explosion more likely. That has now replaced that with an exchange rate that is too high, limiting Ireland’s capacity to export her way out of debt. Not all the achieveement prior to 2007 was false, as a visit to Dublin will testify.
The cuts in Corporation Tax were an excellent policy, which did enormous good to Ireland. The low tax rate brought in many more international businesses, and with them much more revenue. Raising the rate too far from here could lose Ireland that advantage and could cut their revenues in the medium term, making the deficit worse. There is already a substantial outflow of people from Ireland seeking better oportunities elsewhere. An outflow of companies would add to the trouble.
The UK’s strategy for cutting its deficit over four years has always relied on a large increase in tax revenue. Total public spending goes up every year over the next four years in cash terms, despite some difficult cuts in some areas. There is strong growth in spending on Overseas Aid and the EU, increased pension payments, and small real growth in Health and schools. By 2014-15 current spending will be up by £92billion compared to last year, and tax revenue is forecast to be a massive £176 billion higher.
A higher rate of VAT is part of the that forecast. The OBR does not think the VAT increase so worrying that it stops growth. Most of the increase in tax revenue is expected to come from economic growth. That it makes it doubly important the rest of tax policy is geared to promoting growth. The Irish debate over Corporation Tax is instructive for us. Ireland’s Corporation Tax revenue surged after the cut the rate. The sooner the UK cuts her rate the better. The government has said it will laser in on measures to promote growth. That will require a substantial business freedom element to Mr Clegg’s Freedom bill soon. Further reductions in tax rates on earning and investing, on working and enterprise, would also help, and could increase the revenues.